January 2017

While it does appear that energy and metals prices have been recovering from the low points of 2015, oversupply and muted demand continues. Michael Hseuh and Grant Sporre summarise the fundamentals and commodity finance dealmakers comment on the implications for 2017 transactions.

There was a strong finish to 2016 for commodities at +12.2% in total returns, which has put it well ahead of other asset classes, but this sets up a tough set of comparators going forward into 2017. While we maintain an upward bias for energy, we take a neutral stance regarding industrial metals, and believe that a difficult environment may persist with precious metals, suggesting that the sector overall will be hard placed to repeat its very strong performance.
table

Crude oil

OPEC has followed through with its Algiers accord of 28 September 2016 to reach the Vienna Agreement of 30 November to limit output at 32.5 million barrels a day (m b/d), although our assumptions remain unchanged that OPEC-14 will actually produce roughly 33.2m b/d in 2017. This leaves our already-constructive fundamental outlook unchanged, in the sense that surpluses will reliably turn to deficits from Q2 2017, supporting our outlook for US$55/bbl Brent in 2017 and US$65/bbl Brent in 2018.


In our opinion, the non-OPEC contribution of 558,000 barrels a day (k b/d) to supply discipline may amount to only 200k b/d of tightening at best owing to the ramp-up in Russian and Kazakhstan production to the October baseline from which cuts are assessed, and the fact that we already expect Mexican production to decline by minus 160k b/d in 2017 (more than its agreed minus 100k b/d cut).

We also curb our enthusiasm with the knowledge that OECD commercial crude oil stocks are still 209m bbl above normal, and that forecast deficits of 300–400 kb/d in 2017–19 are not in the same league as deficits of 1.0–1.4m b/d experienced in 2007, 2010 and 2011. We believe there is still plenty of time for market participants to doubt the pace of tightening in light of last week’s strong oil-directed rig count addition in the United States which may threaten to push US supply growth toward the high end of our +0.8–1.3m  b/d year-on-year forecast range in 2018.

Natural gas

In US natural gas we believe that risks have shifted to the upside versus our price forecast deck mainly as a result of continued slow growth in supply and only a partial recovery in upstream spending in the Marcellus in 2017. Associated gas production may therefore take up the mantle as US oil production rises. It has been a lucky coincidence that warmer-than-seasonal weather depressed residential and commercial demand in 2016 to match the decline in production. On a partial normalisation of weather, we believe that the small surplus in stocks may be eliminated this winter.

Thermal coal

In thermal coal the sharp decline in seaborne prices since the mid-November peak now means that the relationship between seaborne coal and domestic Chinese coal prices has returned to the prevailing relationship, wherein Indonesian and Russian East Coast exports are favoured. However, owing to the likelihood of a slow Chinese production ramp-up in response to policy loosening, we expect prices may remain somewhat elevated at Newcastle US$81/t and Richards Bay US$78/t in Q1-2017. Furthermore we do not expect prices to fall below the Chinese government-preferred threshold of Qinhuangdao 5500k at RMB 500/t,Newcastle US$67/t and Richards Bay US$65/t.

Industrials

In our view the demand outlook from China still looks favourable, although we expect demand growth rates to slow modestly as the restocking impetus of 2016 slows down. However the Politburo remains focused on stable growth and our lead indicators continue to suggest the conditions for metals intensive demand growth remain favourable. We continue to look for signs of the credit impulse in China turning negative. We think this occurs in Q1’17 but historical correlations suggest that there is a lag of six to nine months before commodity demand is impacted.

2016 has delivered a cyclical recovery far bigger than we were forecasting this time last year, with average prices up 34% year to date across the commodity complex. As a result commodity prices can no longer be considered “cheap” with prices well above their long run real averages andin most cases well above their marginal costs. In base metals, investor positioning is well and truly long, with spot prices in some instances well ahead of the fundamentals in our view.

Investor positioning or rather repositioning may upend our fundamental view. Mean reversion in the base metals complex suggest copper and aluminium should outperform nickel and zinc in 2017. However from a fundamental view, we continue to prefer nickel, zinc, palladium and coking coal (in that the price trajectory could be far more bullish than our forecasts would suggest).

Although we have upgraded our Chinese and US steel demand forecasts for 2017, we still forecast flat global iron ore demand. The weight of new supply means that the market will still be moderately oversupplied in our view. That means that for every new tonne that is added, another high-cost tonne needs to be squeezed out. We continue to see the domestic Chinese producers and some peripheral producers being squeezed out. We think the point at which further resistance crumbles is in the low US$50s. In a decent demand environment, we think Vale will be able to defend the price above US$50/t by managing supply, hence our US$56/t price forecast for next year. However, the outlook is more challenging for 2018. Simply put, a lot of Chinese stimulus will have delivered flat steel demand for 2017. A lot more will be required to do the same in the future, and with more low cost supply on the way, the next resistance point is closer to US$45/t in our view.

Precious metals

A conservative estimate of President Trump’s pre-election policies would imply a 2.25-2.5% range for US GDP growth. However our more optimistic house view raises our US growth forecast for 2017/18 to 3.0/3.3%. Our economists’ outlook is based on stronger business investment spending, a mild boost to consumption, and a self-reinforcing cycle of stronger demand driving faster capital spending.

This above consensus view of US growth implies a continuation in the sell-off of US treasuries and upside for the US equity market, both of which make for a negative environment for gold. Our 2017 gold price forecast of US$1,200/oz factors in a lagged and less than perfect implementation of the much heralded fiscal stimulus, but should our house view of US growth and US ten-year Treasury yields (3.6% by end Q2) play out, there is at least US$100/oz downside to our forecast.

Platinum fundamentals took a turn for the worse in 2016 and we think 2017 is shaping up to be another tough year. The demand pull over the next two to three years remains weak with the shift in technology to beat Euro 6d emission standards favouring less PGM-rich solutions. We now forecast modest surpluses over the next few years and it is only by virtue of our stronger rand forecast that we see the average price flat in 2017, slightly above the current spot price. We forecast the palladium market to continue being in a deficit market and the metal remains one of our top picks. However there is a rising risk of a short term pull back as Chinese autos sales slow following the tax change. Our average 2017 forecast is 12% higher than 2016, but is c.US$40/oz below the current spot price.

Grant Sporre and Michael Hseuh are Research Analysts at Deutsche Bank Research. These insights have been adapted from the Deutsche Bank Commodities Quarterly, 15 December 2016

Implications for 2017 commodities finance transaction banking

John MacNamara, Managing Director and Global Head of Structured Commodity Trade Finance at Deutsche Bank comments, “Clearly we’re in a much more benign environment for the average commodity corporate than we have been for a couple of years, and corporates are reaping their rewards from a prolonged period of cost cutting. For this reason, we look forward to a happier 2017.”

Michael Hseuh

Research Analyst, Deutsche Bank

Michael Hseuh

Grant Sporre

Research Analyst, Deutsche Bank

Grant Sporre

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